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Corporate virtualization

A global study of cost externalization and its implications on profitability

Businesses around the world have been on a journey, whether deliberate or not, of cost externalization. A significant portion of any business’ revenues are now being spent outside their own organization. What was once a salary, is now a supplier invoice.

What’s surprising is the extent to which the externalization of costs has occurred. An analysis of nearly 2,000 organizations’ (across all major countries) financial reports found that, on average, revenues spent on labor costs now account for only 12.5 percent of total revenues. In contrast, non-labor costs account for 69.9 percent.

The larger role that suppliers play increases the need for management of the related external activity, as well as creating more complexity. And this management can improve business performance significantly. But to drive the full benefit from suppliers, companies must have full oversight of supply operations so that productivity, operational and reputational risk, innovation and intellectual property are all properly maintained.

However, the statistics put into sharp relief that management practice has not kept pace with this greater externalization of cost. With non-labor costs now accounting for a significant portion of revenue, it is clear that only a relatively small number of businesses have transformed their supplier relationship management models to account for this change.

The implications of this go to the heart of business and operational management. Management that neglects the strategic aspects of their supplier base, or fails to maximize its value, risks missing out on developing competitive advantage and significant source of long term shareholder value.